US economy: Wage growth is accelerating, but unevenly

The US labour market is going from strength to strength. In September a net number of 134,000 jobs were created, pushing headline unemployment down to 3.7%, a 49‑year low. Nominal wage growth has begun to accelerate only recently, rising by 2.8% year on year in the third quarter of 2018. We expect nominal wages, and eventually inflation, to increase more noticeably in late 2018 and early 2019 as employers become less resilient to demands for wage increases.

Even factoring in the recent uptick, nominal wage growth has been much more subdued than would normally be expected with the unemployment rate at a near-record low. Nominal wage growth averaged 2.6% year on year in the first half of 2018—only marginally higher than average growth of 2.5% in 2016 and 2.3% in 2017, when the unemployment rate was higher (ranging from 5% down to 4.2% over the two years).

What is keeping wages down?

Over the past year regional central banks in the US have highlighted a number of factors contributing to slower than anticipated wage growth. One of the structural factors is the declining rate of labour union membership, which may be contributing to the lag between falling unemployment and pressure on employers to increase wages. Just 10.7% of wage and salary workers were members of unions in 2017, according to the US Bureau of Labour Statistics (BLS), down from 20% in 1983 (the first year for which comparable data are available).

Another key factor, which we have highlighted over the past year, is a likely decline in the threshold for full employment. Although headline unemployment is at a near-record low, at 3.7% in September, some pockets of slack in the labour market are being absorbed more slowly. The BLS estimates that the U‑6 rate of unemployment—a broader measure that includes people who are marginally attached to the labour force (not currently looking for work, but would like to work) and those who are employed part-time for economic reasons—is much higher than the headline rate, at 7.5% in September. U‑6 unemployment has also declined in recent years, but its path has been bumpier, falling from 8.3% in September 2017 to 7.6% in May 2018, before rising again, to 7.8%, in June. It has remained fairly flat, at 7.5%, since then.

This implies that some of the remaining spare capacity in the labour market has yet to be fully absorbed. Research from the Federal Reserve Bank of Dallas has highlighted the role that the expanding gig economy plays in keeping wage-growth down; in the proliferating gig economy, which relies heavily on contract workers, often in transport and delivery, an increasing number of workers may find it difficult to move from part-time to full-time work.

Not all bad news

On a positive note, the labour market has expanded in 2017‑18, as strong job creation has encouraged some previously discouraged workers (some of whom would have been included in the U‑6 measure) to resume their job search. Research from the Federal Reserve Bank of San Francisco has highlighted that new entrants to full-time work (including returning workers, those transitioning from part-time to full-time work and those in their first employment) tend to earn below-average wages. As a result, a strong rate of job creation and an expanding labour market can pull down average wages, contributing to slower than expected overall wage growth. Similarly, the large number of retiring baby-boomers has reduced the age profile of the US labour market in recent years, and this will have a similar effect on average wage levels.

Finally, research from the Federal Reserve Bank of Kansas City has also shown that, although the unemployment rate in the US rose quickly during the depths of the global financial crisis in 2008‑09, wage levels were more resilient than they had been in previous economic recessions. This reluctance to cut wages during the recession has probably given employers less room (and less incentive) to increase wages in subsequent years. Although remaining relevant in 2017‑18, we expect these base effects to disappear by the end of 2018, with unemployment hovering at near-record lows.

Times are changing

We therefore expect wage growth to accelerate further in the coming months as major employers increasingly compete for workers. An important sign of this came in early October, when an online retailing giant, Amazon, announced that it would raise the minimum wage for its US workers from US$11 to US$15 per hour, more than double the statutory federal minimum of US$7.25 per hour.

Amazon's move, which applies to 250,000 regular employees, as well as over 100,000 hired for seasonal work, could have widespread repercussions. Other big retailers have also announced minimum pay increases. For example, Target said last year that its starting wage would rise to US$15 per hour by 2020. Walmart, the US's largest private-sector employer, has pushed up its minimum wage to US$11 per hour.

Besides economic factors, Amazon and other large employers, especially in the retail sector, are under mounting political pressure to raise wages for their lowest-paid workers. Activists often cite Amazon as a prime example of the widening income inequality in the US. Jeff Bezos, the company's founder and chief executive, is now the richest person in the world, with a net worth of US$165bn, according to the Bloomberg Billionaires Index. Amazon's other shareholders have also done extremely well, as the company's market value has recently surged above US$1trn.

More than half of the 50 US states have set minimum wages above the federal level. Washington has the highest, at US$11.50 per hour, followed by California and Massachusetts, both at US$11 per hour. Congress last raised the federal minimum wage in 2009. The former president, Barack Obama, pushed for an increase to US$10.10 in 2015 but was rebuffed by the Republican majority, which has generally sided with corporate interests. We expect a renewed push if the Democrats win control of the House of Representatives in the November mid‑term elections, as we forecast they will.

Implications for the Fed

We forecast that nominal wages will increase by 2.9% year on year in 2018 and by 3% in 2019 as the cyclical factors that have been constraining wage growth in recent years begin to wear off. As a result, we expect the Federal Reserve (the central bank) to raise interest rates by another 25 basis points in December, which would be the fourth rate increase this year. We believe that three rate rises are likely in 2019 as the economy continues to expand and wages rise higher. The Fed is likely to take a more cautious approach from the fourth quarter of 2019 onwards as slower consumer spending and the negative effects of the US-China trade war cause the pace of GDP growth to slow.